The International Journal of Business Management and Technology, Volume 2 Issue 3 May-June 2018

ISSN: 2581-3889

Research Article Open Access

The Effect of Audit Quality on Goodwill Disclosure among

Malaysian Listed Firms under the MFRS 136

Essam Rateb A. Alhjaj1, Nur Hidayah Binti Laili2 and Khairil Faizal Bin Khairi3
1PhD candidate, Faculty of Economics and Muamalat, University Sains Islam Malaysia [USIM], Bandar Baru
Nilai, 71800, Nilai, Negeri Sembilan, Malaysia

2,3Assistant Professor of Accounting, Faculty of Economics and Muamalat, University Sains Islam Malaysia [USIM]

Abstract: Accounting for goodwill is again controversial as International Accounting Standard Board adopts the
impairment regime in 2004. Indeed, the adoption of impairment regime regarding Goodwill in accordance with IFRS
makes the annual reports of companies more credible and transparent. However, the new treatment continues to receive
criticism from the academics and practitioners, because they see the impairment regime is based on the discretion of
management, and there is subjectivity inherent in the application of the impairment regime besides the conceptual move
toward fair-value accounting. Hence, there is non-compliance with this standard in many companies around the world.
However, the problem of agency and information asymmetry, which happen between companies‟ management and
shareholders, can be decreased by external audit. This paper investigates the factors that may affect companies‟
compliance with the MFRS 136 Impairment of Assets among the Malaysian listed companies. Based on a review of the
prior literature, this paper proposes a conceptual framework to investigate the impact of audit quality (audit firm size,
audit tenure and audit fees) on the level of goodwill disclosure compliance with the MFRS 136 among Malaysian listed
companies. Evidence from previous studies suggested that the audit quality proxy namely audit firm size, audit tenure
and audit fees positively impact the companies‟ compliance with the MFRS 136.

Keywords: IFRS; IAS 36; MFRS 136; Impairment of Asset; Audit Quality; Goodwill Disclosure.

I. Introduction
After corporate accounting scandals across the United States, Europe and East Asia (e.g. Enron, HealthSouth,
Parmalat, Tyco, WorldCom, and Xerox), there is growing concern regarding accuracy of financial statements globally.
According to Glaum et al. (2004) and Fearnley et al. (2004) these accounting scandals were investigated into the quality
of financial disclosure as well as transparency and credibility in protecting companies‟ stakeholders.

Indeed, the relevant information which is disclosed by companies plays an important role in the decision making
process by stakeholders (Ferrer & Ferrer, 2011). Audited annual reports represent major inputs used by stakeholders, to
evaluate firm‟s financial performance and to make proper business decisions. The quality of auditing and its ability to
ensure credible financial reporting plays an important role in minimizing information asymmetry and boosting
shareholders confidence in any stock market (Khlif & Samaha, 2013).

With the adoption of a new goodwill accounting regime by IFRS, goodwill is no longer amortized, but instead tested
at least annually for impairment. As known, goodwill is a controversial asset and the new treatment continues to receive
criticism from the academics and practitioners, because they see the impairment regime based on the discretion of
management (Abu Ghazaleh et al., 2011).

Further, the new IAS36 demands many requirements, and requires companies to provide more disclosure (ESMA,
2013). Thus, it is considered as a complex standard (Linda & LeMaster, 2007), as well as has some ambiguous
requirements (Bepari & Mollik, 2015). Hence, many companies around the world failed to comply with the IAS 36
requirement of disclosure regarding goodwill (Khairi et al., 2013; Glaum et al., 2013; Carlin et al., 2009a; Carlin et al.,
2009b). Previous studies attributed those non-compliances to the lack of established "best practices" for IFRS, the
complexity and the apparent inherent managerial discretion in the new treatment of goodwill. Furthermore, others

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The Effect of Audit Quality on Goodwill Disclosure among Malaysian Listed Firms under the MFRS 136

attributed that to the subjectivity that inherent in the application of the impairment approach (Jarva, 2012; Lee & Yoon,
2012).

This means auditors have to rely more on their own judgment and interpretation of the standards (Zhang, 2011). In
other words, auditors are required to exercise professional judgment when investigating management assumptions and
valuations (Al-Hiyari et al., 2016). This may affect the overall audit quality. However, Hope (2003) suggested that audit
quality is a better execution of accounting standards. According to Arrunada (2004) audit quality is a vital factor
influencing the credibility of financial statements. If quality work is performed, then the audited financial statement
would give an appropriate report, rendering the financial statement useful to users for decision making. External
auditors ensure integrity in the financial reporting process through independent audits of financial statements. Thus,
audited financial statements are deemed more credible than unaudited ones by virtue of the assurance given by an
independent expert, the external auditor (Ismail & Mustapha, 2015).

This paper proposes a conceptual framework to investigate if the Audit quality (Audit firm size, Audit fees and Audit
tenure) has an impact on goodwill disclosure complying with the paragraph 134 requirements according to the MFRS
136 Impairment of Assets among the Malaysian companies listed on Bursa Malaysia. The remainder of the paper is
organized as follows: Section 2 introduces the background of the study; Section 3 highlights the literature review;
Section 4 presents the conceptual framework and hypothesis development and Section 5 summarizes and concludes this
paper.

II. Background

The Malaysian Accounting Standard Board (MASB) adopted the IFRSs and became effective in 2006. Hence, the
Malaysian companies were forced to prepare and present their annual reports according to the IFRS (Carlin et al., 2009).
Before that the treatment of goodwill accounting remained different among Malaysian companies until 2006, and this is
attributed to the absence of a true standard which governs goodwill accounting (Carlin et al., 2009). In particular, some
companies used capitalized goodwill and amortization, while some companies used capitalization but the goodwill was
subjected to impairment review, where as another group used capitalized goodwill and kept it as a permanent asset
(Susela, 1999).

On January 1st 2006, Malaysian listed firms have been requested to prepare and present the financial statements in
accordance with Financial Reporting Standards (FRSs) adopted by the Malaysian Accounting Standard Board (MASB)
(Carlin et al., 2009a). As a result of the adoption of IFRSs, firms must account for goodwill in according of FRS 136,
Impairment of Assets. The FRS 136 is equivalent to the IAS 36 Impairment of Assets. According to the new treatment, the
amortization against goodwill was abolished, and goodwill has been subjected to an annual impairment test or more if
there were any indicators implying that there is any impairment in goodwill value took place, as well as, the impairment
loss will not be retrieved (MFRS 136, 2012).

On 1st August 2008, the MASB published a statement on their plan for full convergence of the MFRSs and IFRSs as
issued by IASB by 1 January 2012 (Deloitte, 2015). Subsequently, the MASB released the approved MFRS Framework,
which was known as the Malaysian Financial Reporting Standards (MFRSs) on 19 November 2011. The accounting
standards issued by the MASB were literally word-for-word identical to those of the IFRSs (KPMG, 2011), and all firms
were required to apply the MFRS framework at the beginning of 2012, except for private ones (MASB, 2015).

Thus, In view of the fact that the MASB recently adopted the MFRS 136, and because of the lack of studies about
goodwill disclosure compliance in Malaysia, this study intends to investigate the impact of the audit quality in
constraining goodwill disclosure.

III. Literature Review

According to Godfrey et al. (2010), financial information basically demands for two intentions: steward and decision
making. With respect to the agency theory, it focused on the steward intention because the separation between
ownership and management leads to a divergence of interests between managers and shareholders, thus, the agency
conflict will increase (Jensen & Meckling, 1976). As such, monitoring managerial decisions becomes essential for
shareholders to assure that their interests are protected (Fama & Jensen, 1983), as well as for ensuring credible and

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The Effect of Audit Quality on Goodwill Disclosure among Malaysian Listed Firms under the MFRS 136

reliable financial reporting. Therefore, financial disclosures will reduce the agency problems which arise from the
conflict between shareholders as principals and managers as agents (Abe & Chung, 2009).

Recently, most global countries have adopted the International Financial Reporting Standards (IFRS), and as reported
by Bova and Pereira (2012) and Khairi et al. (2013), more than100 countries have changed their domestic standards to the
IFRS. Indeed the IFRS have superior merits when compared to same domestic standards of accounting (Hail et al., 2010).
Aside from that, the IFRS offer more convergence and harmonization in accounting treatment around the world (Ferrer
& Ferrer, 2011). Furthermore the standards increase financial information in local and foreign corporations (Chen et al.,
2013). Thus, the companies‟ financial statement could achieve more transparency and credibility (Godfrey et al., 2009).
Therefore, these benefits will decrease the information asymmetry between the companies‟ management and
shareholders (Eiler, 2009). Hence, the company‟s investment efficiency will also be improved (Chen et al., 2013).

Financial disclosure is the information released by companies to the public and may be financial or non-financial,
numerical or qualitative, mandatory or voluntary, and through formal or informal methods (Gibbins et al., 1990).
Meanwhile, mandatory disclosure is the information released by companies in order to meet the standards‟
requirements (Hassan & Marston, 2010), the voluntary disclosure is the information released by companies exceeding
the mandatory requirements and it is considered as optional to provide this relevant information for users of annual
report (Al-Janadi et al., 2011).

Previous literatures have seen that financial disclosure is an effective way to decrease the agency cost (Abe & Chung,
2009), and decrease the information asymmetry between managers and shareholders, as well as among shareholders
themselves. Additionally, it is considered as a basic source for decision making (Ferrer & Ferrer, 2011; Bova & Pereira,
2012). However, previous studies identified the external auditors as an interesting area attributed to the external
auditors ensuring the integrity in the financial reporting process through independent audits of financial statements.
The audit quality of external audit is supposed to act effectively for monitoring and mitigating managerial opportunistic
behaviour, thereby ameliorating agency conflicts and protecting the interests of shareholders (Fama & Jensen, 1983).
Hence, the audit quality is an effective way to decrease the agency conflict and information asymmetry (Xiao et al., 2004;
Watts & Zimmerman, 1983). As such, in the quality of financial statements, auditors play a pivotal role.

Thus it is reasonable to hypothesize that audit quality will enhance the goodwill disclosure compliance under the
MFRS 136 among the Malaysian listed companies.

In the following section, audit quality proxies such as audit firm size, audit tenure and audit fees are discussed for
their impacts on financial disclosure in literature review.

IV. The Conceptual Framework and Hypothesis Development

The audit quality and their relation with goodwill disclosure are integrated in one conceptual framework. Figure (4.1)
explains the proposed framework. In this conceptual framework, audit quality dimensions are the independent
variables and goodwill disclosure is the dependent variable. The current study thus attempts to bridge the gap by
providing the basis for discerning the impact of audit quality on goodwill disclosure compliance under MFRS 136. Then,
sections 4.1- 4.3 will discuss the hypotheses that are developed from the conceptual framework.

Figure (4.1): Audit Quality and Goodwill Disclosure.

Audit Firm Size

Goodwill Disclosure
Audit Firm Size Compliance under
MFRS 136

Audit Firm Size

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The Effect of Audit Quality on Goodwill Disclosure among Malaysian Listed Firms under the MFRS 136

4.1 Audit Firm Size

According to the agency theory, the conflicts that arise between investors and company managers regarding their
interest can be decreased via an external audit (Xiao et al., 2004; Watts & Zimmerman, 1983). As such, in the quality of
financial statements, auditors play a pivotal role. Prior research suggests that large, globally operating 'Big 4' audit firms
provide audits of a higher quality level than smaller, regionally oriented auditors (De Angelo, 1981). Large audit firms
produce more quality audits as compared to smaller firms as well as, large audit firms are expected to be more
independent (Haniffa & Cooke, 2002).

Higher quality audit services are provided by Big 4 firms, and this has been proven by stricter audit procedures
(Francis & Krishnan, 1999) and international evidence (Palmrose, 1988; Feroz et al., 1991). According to Watts and
Zimmerman (1986), a higher audit quality is possible among large audit firms because they possess a superior
monitoring capability. Unsurprisingly, the creditors and investors prefer companies to engage with large audit firms
with international affiliation in order to audit the financial statements of companies (Whiting &Woodcock, 2011).

A positive association between compliance and being audited by the Big N firms has been found in prior studies
(Bepari et al., 2014; Glaum et al., 2013; Glaum & Street 2003; Street & Gray 2001). Glaum et al. (2013) and Bepari et al.
(2014) found audit quality to be a significant determinant of firms' compliance with IFRS for goodwill impairment
testing. Glaum and Street (2003) and Street and Gray (2001) found that firms' compliance with IFRS is positively
associated with the audit quality, with the audit quality being defined in terms of Big-N versus non-Big-N auditors.
Nurunnabi and Monirul (2012), Whiting and Woodcock (2011), Chu and Mathieu (2009), Naser et al. (2002), Raffoni
(1995), and Craswell and Taylor (1992) found a significant association between big audit firms and level of disclosure.
Chu and Mathieu (2009) stated that companies disclose more information in their statement notes if they are audited by
the Big 4.

Thus, based on the agency theory and aforementioned discussion, it is argued that there is a potential relationship
between audit firm size and goodwill disclosure. Thus, the following hypothesis is developed as follows:

H1: Audit firm size has a significant positive impact on the level of goodwill disclosure compliance under the MFRS
136 Impairment of Assets among the Malaysian listed companies.

4.2 Audit Tenure

According to the agency theory, the auditor has an important role in monitoring the doubtful action of a company„s
management by serving to reduce agency cost (Watts & Zimmerman, 1986) and information asymmetry (Aboody & Lev,
2000). Therefore, the manager will be forced to disclose more credible information in financial statements. Indeed, the
relationship between auditors and their clients, in case of long engagement, is controversial. Proponents of audit tenure
argue that audit quality impacted positively in the case of audit tenure (Almutairi et al., 2008). According to Beck et al.
(1988), when the auditor first starts to audit his/her client for the first time, he/she needs to build knowledge about the
company. Hence, the auditor will likely face some challenges early on in the contract to discover any fraud and material
error or misstatement. Consequently, the auditor may produce a lower quality of audit. However, over time, the auditor
may gain more knowledge and experience. Hence, the audit quality will improve.

Meanwhile, the supporters of auditor rotation contend that long audit tenure will more likely affect the independency of
the auditor and impair his/her objectivity (Almutairi et al., 2008). The involvement of a personal relationship between
the auditor and the client will lead to the loss of auditor independence (Flint, 1988). A lengthy tenure is one such threats,
as it may bring about a relationship that is less rigid and formal in nature and develop a sense of loyalty or emotional
relationships which may influence the auditor„s attitude and opinion. As a consequence, a decline in the competence
and quality of the auditors' work may be witnessed (Flint, 1988).

Empirical evidence supports the notion that audit tenure is better for audit quality, compliance with accounting
standards, and the quality of financial statements ( Chung & Kallapur, 2003; Carcello & Nagy, 2004; Stanley & DeZoort,
2007; Chiang & Lin, 2012).. Chung and Kallapur (2003) proposed that the length of auditor tenure is negatively
associated to abnormal accruals. According to Carcello and Nagy (2004), the likelihood of fraudulent reporting is higher
in the initial years of audit engagement. Stanley and DeZoort (2007), indicated that a short audit tenure is negatively
related to the likelihood of restatement. Chiang and Lin (2012) verified the impact of the auditor-client relationship on

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The Effect of Audit Quality on Goodwill Disclosure among Malaysian Listed Firms under the MFRS 136

the disclosure of SFAS 34 Financial Instruments. Their results show that when financial statements are audited by
auditors with market knowledge, the level of information disclosure is higher.

Thus, based on the agency theory and aforementioned discussion, it is expected that there is a potential relationship
between audit tenure and goodwill disclosure. Thus, the following hypothesis is developed as follows:

H2: Audit tenure has a significant positive impact on the level of goodwill disclosure compliance under the MFRS 136
Impairment of Assets among the Malaysian listed companies.

4.3 Audit Fees

Prior researches had been using audit fees as proxy for audit quality. This is because audit fees reflect the magnitude
of audit effort. Higher audit fees are expected to indicate more auditing work, which is expected to enhance audit
quality. Factors that are common across different clients tend to determine audit fees. These factors include client-
specific size, complexity, and risk (Choi et al., 2010). Hay et al. (2008), confirm that the demand for auditing is a function
of the set of risks faced by individual stakeholders to an organization and the set of control mechanisms available for
mitigating these risks. Hence, the more reliability and validity in annual reports the more likely lead to reduce the
auditor„s risk evaluates and less audit efforts are required, thus, leading to charge less audit fees (Yatim et al., 2006).

Beatty (1989), argued that the nature and extent of agency costs vary across organisations and this variation may lead
audit firms to differentiate the quality of their services. Beatty (1989) further proposed that a more precise financial
statement is produced by high reputation firms in the firms' attempt to protect its standing in the market. Therefore, it is
reasonable for audit fees to reflect differences in audit quality. An independent-audit consumer will be required to pay a
premium price when seeking an audit service of higher quality (Copley, 1992). Similarly, Wahab et al. (201) contended
that because companies demand higher audit quality, they incur higher audit fees.

However, the adoption of IFRSs adds a new burden on the auditors. For example, in an impairment test, auditors are
required to exercise professional judgment when investigating management assumptions and valuations (Al-Hiyari et
al., 2016). In addition, the fair value reporting introduces substantial discretion into management estimates (Watts, 2006;
Ramanna & Watts, 2010). This increased discretion can compound agency costs, leading auditors to increase their
assessment of reputation and/or litigation risk and, consequently, their efforts to verify fair value estimates
(Goncharovet al., 2014).

Prior empirical evidence reinforces and supports that the recent transition to the new IFRS has a significant link to the
level of audit fees. Griffin et al. (2009) suggested that the increase in audit fees is associated with the adoption year and
in the following IFRS adoption years in New Zealand. Ding et al. (2008) indicated that the transformation from IAS to
IFRS is regarded as a major accounting event in the auditing arena that is supposed to affect audit fees. This is because
the changes in standards and regulations have increased the difficulties in the audit process.

Thus, based on the agency theory and aforementioned discussion, it is argued that there is a potential relationship
between Audit fees and goodwill disclosure. Thus, the following hypothesis is developed as follows:

H3: Audit fee has a significant positive impact on the level of goodwill disclosure compliance under the MFRS 136
Impairment of Assets among the Malaysian listed companies.

V. Summary and Conclusions

Importance of financial disclosure appears as a consequence of the information asymmetry between the managers
and shareholders and on the other hand, among shareholders themselves. Hence, the adoption of the IFRSs makes the
annual report of companies more credible and transparent, and they offer a lot of information to different users.
However, with the adoption of a new goodwill accounting regime by IFRS which has some ambiguous requirements
(Bepari & Mollik, 2015). Besides, the lack of established "best practices" for IFRS means auditors are required to exercise
professional judgment when investigating management assumptions and valuations (Al-Hiyari et al., 2016). Hence, the
audit quality is a vital factor influencing the credibility of financial statements (Arrunada, 2004).

Therefore, this study aimed to investigate the factors that influence the Malaysian listed companies to comply with
the MFRS 136 by proposing a model that includes three proxy of audit quality that might affect the Malaysian listed

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The Effect of Audit Quality on Goodwill Disclosure among Malaysian Listed Firms under the MFRS 136

companies in complying with the paragraph 134 requirements according to the MFRS 136. These proposed three proxy
of audit quality which are audit firm size, audit tenure and audit fees. In turn, three hypotheses are developed and to
validate the hypothesis, a survey research will be undertaken. Based on previous literature, the proposed model shows
that audit quality plays an important role in improving the goodwill disclosure among Malaysian listed companies
under MFRS 136 Impairment of Assets, where the audit firm size, audit tenure and audit fees positively impact the level of
compliance with MFRS 136.

The present research paper is limited to Malaysian companies‟ compliance under MFRS 136 Impairment of Assets due
to the lack of studies that have been carried out on compliance with MFRS 136. The results of this research paper may be
generalized to all companies listed in Bursa Malaysia.

The proposed model concludes and gathers the important factors that influence the goodwill disclosure compliance
with MFRS 136 Impairment of Assets, which will help future researchers to conduct further studies on disclosure
compliance with accounting standards.

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